Increased government welfare spending could lead to higher inflation

Updated: 2014-02-11 07:00

By Li Kui-Wai (HK Edition)

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Recently, there was a documentary on a local television channel about a priest who took three or four university students to visit street-sleepers in a depressed part of Kowloon. The program showed the priest and students visiting the street-sleepers in an attempt to understand what life is really like for the poor. This was all about sympathy - but there was nothing about how the university students could help the street-sleepers improve their livelihoods, develop skills or join the workforce. One expects university students to come up with more creative ways to help the needy. A similar observation could be made about the recent Policy Address when the Chief Executive expressed sympathy for families who decided not to have a second child because their living space was too small.

Sympathy is about personal feelings - and should be used in individual cases. But it would be naive to think sympathy can be translated into economic policies - especially in regard to welfare provisions. It has more or less become a clich in Hong Kong that the poorer sections of the population need to be protected. Surely one can be sympathetic, but providing blanket-style welfare to these individuals is not the answer. Indeed, the question is how to improve the marketability of individuals with limited skills. While we need to be sympathetic to the needy, we also need to encourage them to contribute to the economy. In other words, help is needed, but we should also help them be self-reliant.

There are important theories about government spending that should be respected without imposing an unwanted burden on other sectors of the economy. Typically, government spending rises in difficult times - as it should to avoid a depression. But government spending should be reduced when the economy is doing well. This is because extra government spending in good times is equivalent to "pouring oil on the fire" and can lead to inflation.

The recent drive to expand welfare spending could have unwanted consequences by leading to higher inflation. Indeed, the state of the Hong Kong economy in 2014 is not all that rosy. On the one hand, the promises of the long-term development in the Policy Address will take time to materialize. On the other hand, the economy is not expected to grow much.

Increased government welfare spending could lead to higher inflation

Moreover, with a rise in welfare expenditure it is likely that businesses in Hong Kong - especially small-businesses - will put up their prices. The reason for this is simple. Once businesses are aware that households have more money to spend as a result of more welfare given by the government, they assume consumers will accept higher prices. Hence, inflation will follow a rise in welfare expenses. Inflation in 2014 is expected to rise considerably. The rise in prices as a result of more welfare expenditure will hurt everyone, including welfare recipients. For non-welfare recipients, life will also be tougher as their purchasing power will be eroded. For welfare recipients, benefits from the increases in welfare will be eroded by inflation. Welfare expenditure should only rise in an economic recession when unskilled people need help, since there will not be much inflation during a recession.

But businesses will see the chance to raise their prices if government welfare spending keeps rising in normal economic times. If economic growth is not forthcoming, or not rising as rapidly as the pace of welfare spending, the rise in inflation coupled with low growth will result in stagflation. This is exactly what the Hong Kong economy does not want because it will hurt everyone. The government will then need to spend even more on welfare. The fiscal burden keeps increasing when economic growth is slow. We need to help the needy, but when welfare spending becomes politicized, its economic consequences can be destructive. Hong Kong leaders must not turn the city into a welfare-dependent economy.

The author is associate professor of the Department of Economics and Finance at City University of Hong Kong.

(HK Edition 02/11/2014 page9)